The Meridian is the official blog of Scott Dauenhauer and Meridian Wealth Management. This blog will update you on financial planning and investment management topics. It will also explore the impact of world events on your portfolio.

Monday, October 18, 2010

The economy is not improving. While the NBER may have called the recession over as of last June - the one in five people who would like to have a job would beg to differ (data from Shadow Stats). I’ve stated on my blog and to many of you that I don’t believe we will have a Double-Dip Recession because we never recovered from the first one. The U.S. is stuck in the D gear - depression. Enter the Federal Reserve.

Last year the Federal Reserve embarked upon a program where it printed nearly $2 Trillion to buy Fannie/Freddie Mortgages and U.S. Treasuries. Combined with changes to accounting rules the market and numerous risk assets shot up, in some cases doubling. Since the money printing stopped earlier in the year stock returns haven’t even been up by 1%. In August the Federal Reserve decided to “keep the motor running” or “warm up the car” so to speak by reinvesting interest and mortgage pre-pays into longer-term U.S. Treasuries - effectively keeping the money supply constant (perhaps I should say the Reserves constant). All of this in a prelude to the next big event which many believe will happen at the November FOMC meeting, but could be pushed to the December meeting - Quantitative Easing 2.0. This simply means more money printing to buy Treasury bonds and potentially mortgages.

The belief that more money printing is on the way and that it is a solution to our economic woes has been witnessed on Wall Street. Stocks had their best September in 77 years and there are now economic commentators who believe you cannot lose in stocks - regardless of what the economy does. In fact, it has gotten so bad that now the Street is collectively hoping economic data is bad so that the Federal Reserve will follow through with its plan to print more money. In short, economic improvement is good for stocks - economic depression is even better for stocks. Anybody see anything wrong with this thought process? Less you think the Federal Reserve is the only Central Bank doing this, be forewarned that the Bank of Japan is now printing money to buy Exchange Traded Funds and Real Estate...is the U.S. next?

Stock prices are driven by short-term forces, but over the longer-term they are driven by valuations and stocks are not priced for superior or even average returns going forward. If the economy was devolving and stocks traded for 10 times earnings - I could be excited about the prospects for stocks, even if I wasn’t hopeful about the economy. At 20 times earnings stocks are priced for perfection, if anything goes wrong they will suffer.

The question is no longer whether we should print more money, but how much more should we print? We will likely find out soon, but it is now clear that low interest rates are here to stay - for a long time. The goal of the Fed is to get you to stop saving your money in banks, money markets and short-term instruments that yield next to nothing and instead use that money to speculate on more risky assets such as stocks, long-term bonds and anything that will get asset prices up. The goal is to boost asset prices so they can be sold off bank and other balance sheets - to some greater fool...guess who that fool is?

There is an old phrase - “Don’t fight the Fed” and it appears Wall Street is following it. But should you? The answer is no - you shouldn’t follow the adage - you SHOULD fight the Fed. You cannot print your way to prosperity. If you could, why would anybody produce anything? Why is there still hunger in the world if the solution is simply to fire up the printing press?

I don’t pretend to know the short-term implications of Federal Reserve short-term thinking, but my belief is that we are on the wrong path. The Federal Reserve, led by Ben Bernanke is leading us toward a cliff and instead of building a bridge most of the pundits have decided to strap on bunging gear and pray that the cord is connected...to something. If the term Lemmings comes to mind it is only because it is appropriate.

Investing in this environment will not be easy and returns will likely not be great (though I do not discount a stock boom, but believe if it happens it will bust). My strategy is to create as much flexibility as possible and take risks where appropriate. My advice to those saving for retirement is to continue saving as much as you can, for those in retirement it is to preserve your assets as much as possible.

While my quarterlies don’t appear to be getting any less gloomy, you might be surprised to hear that I am quite an optimist long-term. I believe the world is on the verge of scientific discovery that will literally make the past one-hundred years look like the stone ages. It will take some time, perhaps decades - but the advancements in bio-tech, medicine, technology, energy and education will be leaps - not steps. The one constant will be change (usually that phrase annoys me, but I believe it will be true). The changes that will take place likely won’t be easy and the immediate impact of such changes can’t be accurately gauged. If you think the iPad is cool (and I do) you haven’t seen anything yet - one day the iPad will be akin to an 8-track player. The problem we have now is that there are too many structural issues standing in the way of the global economy and these have to be worked out - but it takes time, lots of time and lots of pain. The future is bright, getting there may not be so.